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First 5-Year Review of the Compact for The The Government of the United States of America First Five-Year Review of the Compact of Free Association, As Amended, Between the Governments of the United States and the Federated States of Micronesia Report to the Congress of the United States of America Table of Contents EXECUTIVESUMMARY 1 PURPOSEOF THE REPORT 1 SUMMARY OF FINDINGS AND RECOMMENDATIONS 1 ASSISTANCEFRAMEWORK OF THE COMPACT 5 PROFILEOF THE FEDERATEDSTATESOF MICRONESIA S PERIODSOF U.S. ASSISTANCE 7 PRE-COMPACTOF FREEASSOCIATION 7 THE COMPACT OF FREEASSOCIATION 7 THE COMPACT'S FIRSTDIRECTFINANCIAL ASSISTANCEPERIOD: FY 1987 - FY2003 8 THE AMENDED COMPACT: FY2004 - FY2023 8 NEW FISCALAND FINANCIAL ACCOUNTABILITY FRAMEWORK 9 FROM GENERALOPERATIONALSUPPORTTO ASSISTANCETO SELECTSECTORS 9 FROM DIRECTPAYMENTSTO ANNUAL GRANTS 13 ANNUAL SECTORBUDGETS 13 GRANT MANAGEMENT RESPONSIBILITIES 13 ENFORCEMENTTOOLS 15 THE JOINT ECONOMIC MANAGEMENT COMMITIEE (JEMCO) 15 FROM GENERALIZATION TO STRATEGICPLANS 16 FROM LINE ITEM BUDGETSTO PERFORMANCEMANAGEMENT AND BUDGETING 17 FROM U.S. DISCRETIONARYGRANTS FOREDUCATION TO SEG 17 FROM RELIANCEON ANNUAL ASSISTANCETO TRUST FUND 18 SOCIOECONOMIC PROFILEOF THE FEDERATEDSTATESOF MICRONESIA 19 POPULATION 19 MIGRATION 20 7 OUT-MIGRATION 20 COMPACT IMPACT 20 GDP, GROWTH AND STRUCTURAL CHANGE 21 STEADY DECLINE IN ECONOMIC ACTIVITY 21 EMPLOYMENT AND WAGES 23 WAGE RATES 25 EXTERNAL DEBT 26 FISCAL POLICY 27 DEVELOPMENTS IN THE PRIVATE SECTOR 29 ECONOMIC RISKS AND VULNERABILITIES 30 MACROECONOMIC WEAKNESSES 30 LACK OF ESSENTIAL REFORMS 31 TAX REFORM 31 SLOW PACE OF REFORM 32 IMPLEMENTATION PROJECTED IN FY 2011 34 FOREIGN INVESTMENT REFORM 34 MODEL LAW DEVELOPED 34 ATIEMPTED NATIONWIDE IMPLEMENTATION 35 UNEVEN TREATMENT BY THE STATES 35 PUBLIC ENTERPRISE REFORM 35 COMPACT TRUST FUND VIABILITY 36 TRUST FUND PROVISIONS 36 PROJECTED LEVEL AND ACTUAL VALUE 36 OTHER RISKS AND VULNERABILITIES 37 POOR GOVERNANCE 37 POOR STATISTICAL CAPACITY 37 EFFECTIVENESS OF U.S. FINANCIAL, PROGRAM AND TECHNICAL ASSISTANCE 38 THE EDUCATION SECTOR 38 COMPACT OBJECTIVES, USES AND BUDGET TRENDS 38 ii EDUCATIONAL DEVELOPMENTS 38 DATA COLLECTIONREPORTING 38 INCREASEDACCESSTO EDUCATION 39 DECLINING STUDENT ENROlLMENT 39 LOW STUDENT ACHIEVEMENT 40 DISCOURAGINGSTUDENT RETENTIONRATES 40 DECLINING COM GRADUATESAND UNKNOWN IMPACT OF SCHOLARSHIPS 40 FOCUSON TEACHERCERTIFICATION 41 PROBLEMATIC TEACHERATTENDANCE 42 INEFFECTIVEINTEGRATION OF PROGRAMS FUNDED BYTHE SEG 42 MOVING EDUCATION FORWARD 42 LIMIT USESOF AMENDED COMPACT AND SEGGRANTS 42 THE SEGSHOULD BE MAINTAINED 43 BUDGETING ROlES NEED CLARIFICATION 44 REEXAMINE FISCALPRACTICESAND SUBSIDIES 45 SCHOLARSHIPPOLICIESAND TRACKING NEED IMPROVEMENT 46 JEMCO MUST BE CONCERNEDWITH SUSTAINABILITY OF POST- SECONDARYEDUCATION 46 FSM EDUCATION SYSTEMSMUST GIVE ATTENTION TO COMMUNTIY INVOLVEMENT 47 THE HEALTH SECTOR 47 COMPACT OBJECTIVES,USESAND BUDGETTRENDS 47 GRANT TOTALS, PROPORTIONALSHARESAND USES 48 REDRESSINGPRIORDEFICIENCIES 48 PERSONNELAND NON-PERSONNELCOSTS 49 PERCAPITA HEALTH DOlLARS 49 TEMPERED EFFECTSOF EARLYBUDGET INCREASES 50 HEALTH SECTORPERFORMANCE 50 iii PROGRESS IN REACHING FIVE-YEAR PERFORMANCE TARGETS 50 HEALTH INFRASTRUCTURE DEVELOPMENT 59 OTHER INDICATORS OF HEALTH 59 SUCCESSFUL RESPONSE TO SIMULTANEOUS OUTBREAKS OF MDR-TB 60 RISKS AND VULNERABILITIES 61 DEPENDENCE ON AMENDED COMPACT AND OTHER U.S. FEDERAL ASSISTANCE 61 INATTENTION TO PLANNING 64 DELIVERY OF HEALTH CARE IN REMOTE SETTINGS 65 THE PUBLIC SECTOR INFRASTRUCTURE PROGRAM 65 PRIORITY OF THE AMENDED COMPACT 65 SENSE OF CONGRESS 65 DEVELOPMENT PROGRESS 66 DISAPPOINTING START 66 STALEMATE OVER ISSUES 66 MEASURABLE PROGRESS BEGAN IN 2007 68 FINDING WAYS FORWARD 68 PRIVATE SECTOR DEVELOPMENT 68 SECTOR OBJECTIVES AND PRIORITIES 68 U.S. GRANT FUNDING AND ACTIVITIES FROM 2004 THROUGH 2008 69 GRANT AWARD TOTALS 69 INITIAL DIFFICULTY ADAPTING TO NEW USE 69 SUCCESSFUL GRANT-SUPPORTED ACTIVITIES 70 BARRIERS TO PRIVATE SECTOR DEVELOPMENT 71 THE ENVIRONMENT SECTOR 72 PURPOSE OF THE GRANT 72 FUNDING HISTORY AND GRANT USES 73 ISSUES AFFECTING EFFECTIVE GRANT PLANNING AND IMPLEMENTATION 73 iv OVERLY BROAD MANAGEMENT ISSUES 73 PLANNING 74 PUBLIC SECTOR CAPACITY BUILDING 75 PURPOSES OF THE SECTOR GRANT 75 GRANT FUNDING HISTORY AND USES FROM 2004 THROUGH 2008 75 FUNDING HISTORY 7S FSM-WIDE PROJECTED BUDGETARY CRISIS OMPTS TRANSITIONAL GRANT USE 75 FOCUS ON IMPROVED FINANCIAL ACCOUNTABILITY 76 IMPROVED PERFORMANCE MANAGEMENT 76 GENERAL FUND CRISES AND REDUCTION IN FORCE IN KOSRAE AND CHUUK 77 NEED TO FOCUS CAPACITY BUILDING ATTENTION 77 PLANNING FOR PSCB 77 CONTINUING NEED 77 THE DISASTER ASSISTANCE EMERGENCY FUND SECTOR 78 SINGLE AUDIT ASSISTANCE 78 JUDICIAL TRAINING 78 EXTENDED FEDERAL PROGRAMS, SERVICES AND TECHNICAL ASSISTANCE 79 CONCLUSIONS AND RECOMMENDATIONS 82 v EXECUTIVE SUMMARY Purpose of the Report This report reviews the terms of the Compact of Free Association between the Government of the United States (U.S.) and the Government of the Federated States of Micronesia (FSM) as required by Section 104(h)(2) of Public Law 108-188, the Compacts of Free Association Amendments Act of 2003 (Amended Compact). The law states that the review is to occur during the year of the fifth, tenth and fifteenth anniversaries of its enactment. The Amended Compact was enacted on December 17, 2003. The fifth year of implementation ended in FY 2008 on September 30, 2008. The report addresses the overall nature of the relationship between the U.S. and the FSM; describes the general social, political and economic conditions of the FSM, including estimates of economic growth, per capita income and immigration rates; and assesses progress made in the following areas: • The use and effectiveness of United States financial, program and technical assistance; • The status of economic policy reforms including but not limited to progress toward establishing self-sufficient tax rates; • The status of efforts to increase investment including, the rate of infrastructure investment of U.S. financial assistance under the Amended Compacts, non-U.S. contributions to the FSM trust fund, and the level of private investment; and • The report considers the operating requirements of the FSM in meeting its strategic development objectives and offer recommendations on ways to increase the effectiveness of United States assistance. Summary of Findings and Recommendations The FSM is in a fragile fiscal condition from the effects of the recent worldwide recession, inflation, investment decisions and the timing of annual decreases in annual Compact grant assistance. A large public sector dominated the economy while the private sector was small and operated in an environment often unfriendly to foreign investment. Weak internal fiscal policies and sluggish progress in instituting necessary tax and other reforms also contributed to the situation. FY2004 through FY 2008 was a difficult period of adjustment to the new terms and conditions for financial assistance under the Amended Compact. Challenges with communication and coordination between the FSM national government and the states were barriers to the implementation of the Amended Compact during the five-year reporting period, resulting in the submission of late financial and performance reports or none at all. Financial and performance r"oortin" did not meet the letter and spirit of the Amended Compact and its subsidiary Fiscal Procedures Agreement. Annual budgets generally lacked specific performance objectives, priorities, and targets that linked back to the FSM's Strategic Development Plan (SDP). At the end of the reporting period, Infrastructure funds remained unspent because of management issues and difficulty in setting priorities for capital investment that took the interests of the nation into consideration rather than the parochial interests of individual states. land titling problems that existed before the Amended Compact remained unresolved. While there was some improvement in educational and health outcomes, there need to be better results within these sectors. Development planning, budgeting practices, and performance monitoring by the FSM did not meet the new accountability regimen required by the Amended Compact. Processes and tools need improvement and plans need to be reviewed and updated to be useful. Most significantly, the FSM has not planned ahead for the impact that Compact-mandated decreases in annual financial assistance would have on the Amended Compact's three priority sectors and for support for private sector development, improving the human environment, building capacity in management, accounting, and other areas critical to effective FSM governance. The Amended Compact sets forth a process for collaborative management of annual allocations and related policy decision-making by the U.S. and the FSM through the Joint Economic Management Committee (JEMCO). It is primarily to that body that this review addresses recommendations to improve the use and effectiveness annual assistance from the United States. Recommendations: 1. The bilateral JEMCO should aid the FSM in planning for the annual decreases in grant assistance, especially with regard to the priority sectors of education, health, and public sector infrastructure development. 2. The FSM and United States should actively seek third-party donors and collaborate in examining the projected income from the Trust Fund for the People of the Federated States of Micronesia after 2023, and explore options that may assist the Fund to increase its projected value within the bounds of acceptable
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